TENETS OF DOW THEORY

Charles Dow was the founder of the Wall Street Journal and, by trying to understand the market
behaviour, he developed a series of 6 basic tenets which are now the basis of the technical analysis.
Dow Theory is a trading approach developed by Charles Dow who is also known as the father of
Technical Analysis. It is still the basis of technical analysis of financial markets. The basic idea of Dow
Theory is that market price action reflects all available information and the market price movement is
comprised of three main trends.
Charles Dow identified 3 main trends:
 The primary movement.
Its major trend and it can last from a year to several years.
Nobody can really predict the duration and the length of this cycle, it can’t be manipulated.
 The medium swing. 
It’s a secondary movement and Charles Dow observed it usually retrace between the 0.33% and the
0.66%.
The duration could be between one and 3 months.
 The minor movements.
They are the shortest and the more likely to be manipulated.
The standard duration could be between from an hour to one month.
The 3 phases of the Stock Market
Charles Dow notices that movement of a standard primary movement was characterize by 3 main
phases:
1. ACCUMULATION
In this phase the market is moving slow and it's close to its minimum.
In this moment the PANIC reign over the less informed market operators and the mass media. The Smart
Money are secretly buying when the crowd is panic selling absorbing their short orders.
2. TREND. ⇑
This is the moment where all the markets participants are becoming aware of the bullish move and
they're starting to buy.
The general mood is hope and optimism.
3. DISTRIBUTION.
In this last phase the market it's overheating.
The crowd, thanks to mass media, now knows that the market is bullish and they can't wait to buy.
The optimism turns into euphoria.
Dow Theory is a trading approach developed by Charles Dow who is also known as the father of
Technical Analysis. It is still the basis of technical analysis of financial markets. The basic idea of Dow
Theory is that market price action reflects all available information and the market price movement is
comprised of three main trends.
The 6 tenets of Dow Theory’ are discussed below:
1. Market moves in summation of three trends
(1) The PRIMARY TREND- It can be as long as years and is the ‘main movement’ of the market.  (2)
The INTERMEDIATE TREND- lasting between 3 weeks to several months, retraces the last primary
move some 33-66% and is difficult to decipher. (3)The MINOR TREND- is least reliable, lasting from
several days to few hours, constitutes of noise in market and may be subject to manipulation.
2. Market trends have three phases
Be it the bull trend or the bear trend, either ways there are three well defined phases for each. For uptrend,
the phases are Revival of confidence (accumulation), Response (public participation),Over-confidence
(Speculation) .The three defined stages of the Primary Bear Trend are Abandonment of hope
(Distribution),  Selling on decreased earnings (doubting),  Panic ( distressed selling )
3. All news is discounted in the stock market

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Primary Market Reforms in India – SEBI Guidelines:-
SEBI has introduced various guidelines as regulatory measures for capital issues. They are as below:
1. Disclosure of All Material Facts is made Compulsory: SEBI has made it compulsory for companies do
disclose all the facts and risk factors regarding the projects undertaken by the company. The basis on
which the premium amount is calculated should also be disclosed by the company as per SEBI norms.
SEBI also advises the code of ethics for advertising in media regarding the public issue.
2. Encouragement to Initial Public 0ffers: In order to encourage Initial Public Offers (IPO) in the primary
market, SEBI has permitted companies to determine the par value of shares issued by them. SEBI has
allowed issues of IPOs to go for “Book Building” – i.e. reserve and allot shares to individual investors.
But the issuer will have to disclose the price, the issue size and the number of securities to be offered to
the public.
3. Increase of Popularity to Private Placement Market: In recent years, private placement market has
become popular with issuers because of stringent entry and disclosure norms for public issues. Besides
low cost of issuance, ease of structuring investments and saving of time lag in issuance are the other
causes responsible for the rapid growth of private placement market.
4. Underwriting has made Optional: To reduce the cost of issue in primary market, SEBI has made
underwriting of issue optional. However, the condition that if an issue was not underwritten and was not
able to collect 90% of the amount offered to the public, the entire amount collected would be refunded to
the investor is still in force.
5. Issue of Due Diligence Certificate: The lead managers have to issue due diligence certificate, which
has now been made part of the offer document.
6. Conditions regarding Application Size etc.: SEBI has raised the minimum application size and also the
proportion of each issue allowed for firm allotment to institutions such as mutual funds.
7. Regulation of Merchant Banking: SEBI has brought Merchant banking under its regulatory framework.
The merchant bankers are now to be authorized by SEBI. Merchant bankers, now have a greater degree of
accountability in the offer document and issue process.
8. Imposition of Compulsory Deposit on Companies making Public Issues: In order to induce companies
to exercise greater care and diligence for timely action in matters relating to the public issues of capital,
SEBI has advised stock exchanges to collect from companies making public issues, a deposit of one per
cent of the issue amount which could be forfeited in case of non-compliance of the provisions of the
listing agreement and, non-dispatch of refund orders and share certificates by registered post within the
prescribed time.
9. Reforms as to Mutual Funds: The Government has now permitted the setting up of private mutual
funds and a few have already been set up. UTI has now been brought under the regulatory jurisdiction of
SEBI. All mutual funds are allowed to apply for firm allotments in public issues. To improve the scope of
investments by mutual funds, the latter are permitted to underwrite public issues. Further, SEBI has
relaxed the guidelines for investment in money market instruments. Finally, SEBI has issued fresh
guidelines for advertising by mutual funds.
10. Vetting of Offer Document: SEBI vets offer documents to make sure that the company listing the
shares has made all disclosures in it. All the guidelines and regulatory measures of capital issues are
meant to promote healthy and efficient functioning of the issue market (or the primary market).
Despite all these steps, there are flagrant breaches of issue procedures through collusion between
unscrupulous promoters and corrupt officials in the lead banks and even of the top officials of SEBI.
Trading and Settlement Procedure:-
In the stock market, there is always a buyer and a seller. So, when a person buys a certain number of
shares, there is another trader who sells the shares. This trade is settled only when the buyer receives
the shares and the seller receives the money.
Let’s see in detail how the process takes place
There are three phases in a secondary market transaction:
1. Trading

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2. Clearing
3. Settlement
Trading
In the stock market, a large number of trades occur simultaneously. The stock exchanges use an
electronic order matching system to match ‘buy’ and ‘sell’ orders from different traders. This way,
each trade is executed.
For instance, imagine that stock ‘X’ is trading in the stock market.
The buy and sell orders for this stock are as follows: 
 

 
Here the costliest buy prices are matched against the cheapest available sell prices, and whenever the
buy price is less than or equal to the best available sell price a match is done. This of course also
depends on the respective quantities available in the market across buys and sells and is known as
market depth.
So even if a particular price may result in a match, if there is not enough quantity available at the
seller side at that price, the buy order will still not be fully traded.
The market depth is created by brokerages who collect orders from different investors and pass it on
to the stock exchanges, most likely to be the two most popular exchanges in India—the Bombay
Stock Exchange (BSE) and the National Stock Exchange (NSE). In this process, brokerages act as the
intermediary between the investor and the stock exchange.
Clearing
Once two orders match and a trade is executed, the clearing process takes place. Clearing is the
identification of what security is owed to the buyer and how much money is owed to the seller. The
entire process is managed by ‘clearing houses’. These are independent entities.
For example, imagine that there are two traders: Ramesh and Suresh.
However, in the real market scenario, traders tend to conduct multiple transactions. As a result, the
clearing house identifies all the transactions and the net amount or net securities owed to the trader
are calculated.
Settlement
The next step is to fulfil the financial obligations identified in the clearing step. This involves the
transaction settlement for the buyers and sellers.
So once the buyer receives the security and the seller receives the payment, the transaction is settled.
Role of Depositories and Depository Participants (DPs)
In this entire process, there is another important intermediary known as the depository.
A depository is an institution that holds and facilitates the exchanges of securities. In India, the two
depositories are the National Securities Depository Limited (NSDL) and the Central Depository
Service (India) Limited (CDSL).
These depositories allow brokers to deposit securities so that activities such as book entry and record
keeping services can be performed.
In order to trade in the secondary market, the security should be held in electronic form by the
investor. DPs or Depository Participants (usually your broker firm) act as intermediaries between the
depository and the investor. They are involved in the dematerialization and transfer of securities. 
In addition, the settlement of securities is done through the demat account that the investor holds
with the DP. 

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Remember
A trade in the stock market takes place in an instant. But for that to happen smoothly and efficiently,
all these processes take place in the background. And knowing the whole process may help you
understand how the stock market works better.
 
1] Selecting a Broker or Sub-broker
When a person wishes to trade in the stock market, it cannot do so in his/her individual capacity. The
transactions can only occur through a broker or a sub-broker. So according to one’s requirement, a broker
must be appointed.
Now such a broker can be an individual or a partnership or a company or a financial institution (like banks).
They must be registered under SEBI. Once such a broker is appointed you can buy/sell shares on the stock
exchange.
2] Opening a Demat Account
Since the reforms, all securities are now in electronic format. There are no issues of physical shares/securities
anymore. So an investor must open a dematerialized account, i.e. a demat account to hold and trade in such
electronic securities.
So you or your broker will open a demat account with the depository participant. Currently, in India, there are
two depository participants, namely Central Depository Services Ltd. (CDSL) and National Depository
Services Ltd. (NDSL).
3] Placing Orders
And then the investor will actually place an order to buy or sell shares. The order will be placed with his
broker, or the individual can transact online if the broker provides such services. One thing of essential
importance is that the order /instructions should be very clear. Example: Buy a 100 shares of XYZ Co. for a
price of Rs. 140/- or less.
Then the broker will act according to your transactions and place an order for the shares at the price
mentioned or an even better price if available. The broker will issue an order confirmation slip to the investor.
4] Execution of the Order
Once the broker receives the order from the investor, he executes it. Within 24 hours of this, the broker must
issue a Contract Note. This document contains all the information about the transactions, like the number of
shares transacted, the price, date and time of the transaction, brokerage amount etc.
Contract Note is an important document. In case of a legal dispute, it is evidence of the transaction. It also
contains the Unique Order Code assigned to it by the stock exchange.
5] Settlement
Here the actual securities are transferred from the buyer to the seller. And the funds will also be transferred.
Here too the broker will deal with the transfer. There are two types of settlements,
 On the Spot settlement: Here we exchange the funds immediately and the settlement follows the T+2
pattern. So a transaction occurring on Monday will be settled by Wednesday (by the second working
day)
 Forward Settlement: Simply means both parties have decided the settlement will take place on some
future date. Can be T+% or T+9 etc.
Importance of Trading Volume:-
Volume is simply the total number of buyers and sellers exchanging shares over a given period of time,
usually a day. Higher the volume, more active the share is. The data regarding volume of a share will be
readily available on your online trading screen. Most financial sites carry data about volume.
Trading volume, or volume, is the number of shares or contracts that indicates the overall activity of a
security or market for a given period. Trading volume is an important technical indicator an investor uses
to confirm a trend or trend reversal. Volume gives an investor an idea of the price action of a security and
whether they should buy or sell the security.

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Identifying Momentum
Trading volume can help an investor identify momentum in a stock and confirm a trend. If trading
volume increases, prices generally move in the same direction. That is, if a security is continuing higher
in an uptrend, the volume of the security should also increase and vice versa.
For example, suppose company ABC increased in price by 10% over the past month. An investor is
interested in the company and wants to purchase 1,000 shares. They conduct fundamental analysis of the
company and sees its earnings and revenues have consistently increased over the past year. However, the
investor is not confident the stock will continue in this uptrend and may reverse.
This is where trading volume analysis comes in handy. The investor sees there was a steady increase in
volume over the past month. They also realize it was the highest volume company ABC experienced over
the past two years, and the stock is continuing in the uptrend. This signals to the investor that company
ABC is gaining momentum and the trend should continue higher. The increase in volume causes the
investor to purchase 1,000 shares of company ABC.
Low Activity
Trading volume can also signal when an investor should take profits and sell a security due to low
activity. If there is no relationship between the trading volume and the price of a security, this signals
weakness in the current trend and a possible reversal.
Suppose company ABC extended its uptrend for another five months and increased by 70% in six
months. The investor sees that share prices of company ABC are still in an uptrend and continues to hold
on to the shares. However, over the next few weeks, the stock continues in the uptrend but with a
decrease in volume. This signals to the investor the bullish uptrend in company ABC is beginning to lose
momentum and may soon end.
The following week, shares of company ABC decrease by 10% in one trading day after being in an
uptrend for six months. The stock breaks its uptrend and the volume is very high relative to its average
daily trading volume, or ADTV. The investor sells out of all the shares the next day because the reversal
of trend was confirmed due to the high volume and a decrease in price.
For example if the Stocks volume for the day was 1,500,000 shares that means 1,500,000 shares were
sold by someone and bought by someone on that day.
Volume as such may not be an attractive piece of information. But try to combine the volume data with
support and resistance levels – you‘ll get the real picture.
For example – Say stock A ltd broke a ‘resistance level’ and went up further. Also since it broke through
a critical level we would expect it to go up even more in the near future.
Now, let us also consider the volume traded on that day – say 3 lakh shares were exchanged. On a normal
day 1o lakh shares are traded. That means, Volume was way below average for that day. So, all the big
investors were not trading. They could come in the very next day and decide they are bearish on the stock.
They sell and cause a panic. So the stock goes down the next day.
This is the importance of ‘volume’. Most traders will not buy a stock when it breaks a critical level unless
volume is high. The reverse is also true. If a stock goes down with little volume it could mean the same
thing. The majority of investors were not trading. When they come back they could see this stock and
decide it is too low. So they buy it and the price goes up.
In short, Volume is a critical factor in technical analysis. Any support and resistance level is not valid
unless it is backed by adequate volume. Volume should move with the trend. If prices are moving in an
upward trend, volume should increase (and vice versa). If the previous relationship between volume and
price movements starts to deteriorate, it is usually a sign of weakness in the trend. For example, if the
stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is
starting to lose its legs and may soon end.
MOVING AVERAGE:-
A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action
by filtering out the “noise” from random short-term price fluctuations. It is a trend-following, or lagging,
indicator because it is based on past prices.

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The moving average (MA) is a simple technical analysis tool that smooths out price data by creating a
constantly updated average price. The average is taken over a specific period of time, like 10 days, 20
minutes, 30 weeks or any time period the trader chooses. There are advantages to using a moving average
in your trading, as well as options on what type of moving average to use. Moving average strategies are
also popular and can be tailored to any time frame, suiting both long-term investors and short-term
traders. (See also: The Top Four Technical Indicators Trend Traders Need to Know.)
Why Use a Moving Average
A moving average helps cut down the amount of "noise" on a price chart. Look at the direction of the
moving average to get a basic idea of which way the price is moving. If it is angled up, the price is
moving up (or was recently) overall; angled down, and the price is moving down overall; moving
sideways, and the price is likely in a range.
A moving average can also act as support or resistance. In an uptrend, a 50-day, 100-day or 200-day
moving average may act as a support level, as shown in the figure below. This is because the average acts
like a floor (support), so the price bounces up off of it. In a downtrend, a moving average may act as
resistance; like a ceiling, the price hits the level and then starts to drop again.
Moving averages smooth the price data to form a trend following indicator. They do not predict price
direction, but rather define the current direction, though they lag due to being based on past prices.
Despite this, moving averages help smooth price action and filter out the noise. They also form the
building blocks for many other technical indicators and overlays, such as Bollinger
Bands, MACD and the McClellan Oscillator. The two most popular types of moving averages are
the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). These moving
averages can be used to identify the direction of the trend or define potential support and resistance levels.
The two basic and commonly used moving averages are the simple moving average (SMA), which is the
simple average of a security over a defined number of time periods, and the exponential moving average
(EMA), which gives greater weight to more recent prices.
The most common applications of moving averages are to identify the trend direction and to determine
support and resistance levels. While moving averages are useful enough on their own, they also form the
basis for other technical indicators such as the moving average convergence divergence (MACD).
Because we have extensive definitions and articles around specific types of moving averages, we will
only define the term "moving average" generally here.
Types of Moving Averages
A moving average can be calculated in different ways. A five-day simple moving average (SMA) adds up
the five most recent daily closing prices and divides it by five to create a new average each day. Each
average is connected to the next, creating the singular flowing line.
Another popular type of moving average is the exponential moving average (EMA). The calculation is
more complex, as it applies more weighting to the most recent prices. If you plot a 50-day SMA and a 50-
day EMA on the same chart, you'll notice that the EMA reacts more quickly to price changes than the
SMA does, due to the additional weighting on recent price data.
TREND & TREND LINES:-
As technical analysis is built on the assumption that prices trend, the use of trend lines is important for
both trend identification and confirmation. A trend line is a straight line that connects two or more price
points and then extends into the future to act as a line of support or resistance.
A trendline is a line drawn over pivot highs or under pivot lows to show the prevailing direction of price.
Trend lines are a visual representation of support and resistance in any time frame. They show direction
and speed of price, and also describe patterns during periods of price contraction.
KEY TAKEAWAYS

 A single trendline can be applied to a chart to give a clearer picture of the trend.
 Trend lines can be applied to the highs and the lows to create a channel.

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  The time period being analyzed and the exact points used to create a trendline vary from trader to
trader.
 he trendline is among the most important tools used by technical analysts. Instead of looking at
past business performance or other fundamentals, technical analysts look for trends in price
action. A trendline helps technical analysts determine the current direction in market prices.
Technical analysts believe the trend is your friend, and identifying this trend is the first step in the
process of making a good trade.

 To create a trendline, an analyst must have at least two points on a price chart. Some analysts like
to use different time frames such as one minute or five minutes. Others look at daily charts or
weekly charts. Some analysts put aside time altogether, choosing to view trends based
on tick intervals rather than intervals of time. What makes trend lines so universal in usage and
appeal is they can be used to help identify trends regardless of the time period, time frame or
interval used.

 If company A is trading at $35 and moves to $40 in two days and $45 in three days,
the analyst has three points to plot on a chart, starting at $35, then moving to $40, and then
moving to $45. If the analyst draws a line between all three price points, they have an upward
trend. The trendline drawn has a positive slope and is therefore telling the analyst to buy in the
direction of the trend. If company A's price goes from $35 to $25, however, the trendline has a
negative slope and the analyst should sell in the direction of the trend.

 Example of How to Use a Trendline

 Trend lines are relatively easy to use. A trader simply has to chart the price data normally, using
open, close, high and low. Below is data for the Russell 2000 in a candlestick chart with the
trendline applied to three session lows over a two month period.

Uptrends and downtrends are hot topics among technical analysts and traders because they ensure that the
underlying market conditions are working in favor of a trader's position, rather than against it. Trend
lines are easily recognizable lines that traders draw on charts to connect a series of prices together. The
resulting line is then used to give the trader a good idea of the direction in which an investment's value
might move. In this article, you'll discover how to use this tool. It won't be long before you're drawing
them on your own charts to increase your chances of making a successful trade!
Understanding the direction of an underlying trend is one of the most basic ways to increase the
probability of making a successful trade because it ensures that the general market forces are working in
your favor.
Downward sloping trend lines suggest that there is an excess amount of supply for the security, a sign that
market participants have a higher willingness to sell an asset than to buy it. As you can see in Figure 1
when a downward sloping trendline (black dotted line) is present, you should refrain from holding a long
position; a gain on a move higher is unlikely, when the overall longer-term trend is heading downward.
Conversely, an uptrend is a signal that the demand for the asset is greater than the supply, and is used to
suggest that the price is likely to continue heading upward.
Support and Resistance
Trend lines are a relatively simple tool that can be used to gauge the overall direction of a given asset,
but, more importantly, they can also be used by traders to help predict areas of support and resistance.
This means that trend lines are used to identify the levels on a chart beyond which the price of an asset
will have a difficult time moving. This information can be very useful to traders looking for strategic
entry levels or can even be used to effectively manage risk, by identifying areas to place stop-loss orders.
(For more insight, see Support & Resistance Basics.)

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Technical traders pay particularly close attention to an asset when the price approaches a trendline
because these areas often play a major role in determining the short-term direction of the asset's price. As
the price nears a major support/resistance level, there are two different scenarios that can occur: The price
will bounce off the trendline and continue in the direction of the prior trend, or it will move through the
trendline, which can then be used as a sign that the current trend is reversing or weakening.

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